A loss on a sale to certain related taxpayers may not be deductible, even though you make the sale at an arm’s-length price, the sale is involuntary (for example, a member of your family forecloses a mortgage on your property), or you sell through a public stock exchange and related persons buy the equivalent property; see Examples 1 and 2 in this section.
Losses are not allowed on sales between you and your brothers or sisters (whether by the whole or half blood), parents, grandparents, great-grandparents, children, grandchildren, or great-grandchildren. Furthermore, no loss may be claimed on a sale to your spouse; the tax-free exchange rules discussed in Chapter 6 apply (6.7).
A loss is disallowed where the sale is made to your sister-in-law, as nominee of your brother. This sale is deemed to be between you and your brother. But you may deduct the loss on sales to your spouse’s relative (for example, your brother-in-law or spouse’s step-parent) even if you and your spouse file a joint return.
The Tax Court has allowed a loss on a direct sale to a son-in-law. In a private ruling, the IRS allowed a loss on a sale of a business to a son-in-law where it was shown that his wife (the seller’s daughter) did not own an interest in the company. Losses have been disallowed upon withdrawal from a joint venture and from a partnership conducted by members of a family. Family members have argued that losses should be allowed where the sales were motivated by family hostility. The Tax Court ruled that family hostility may not be considered; losses between proscribed family members are disallowed in all cases.
Losses are barred on sales between an individual and a controlled partnership or controlled corporation (where that individual owns more than 50% in value of the outstanding stock or capital interests). In calculating the stock owned, not only must the stock held in your own name be taken into account, but also that owned by your family. You also add (1) the proportionate share of any stock held by a corporation, estate, trust, or partnership in which you have an interest as a shareholder, beneficiary, or partner; and (2) any other stock owned individually by your partner.
Losses may also be disallowed in sales between controlled companies, a trust and its creator, a trust and a beneficiary, a partnership and a corporation controlled by the same person (more than 50% ownership), or a tax-exempt organization and its founder. An estate and a beneficiary of that estate are also treated as related parties, except where a sale is in satisfaction of a pecuniary bequest. Check with your tax counselor whenever you plan to sell property at a loss to a buyer who may fit one of these descriptions.
Sometimes, the disallowed loss may be saved. When you sell to a related party who resells the property at a profit, he or she gets the benefit of your disallowed loss. Your purchaser’s gain up to the amount of your disallowed loss is not taxed; see Example 4 below.
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